Simple Money: A No-Nonsense Guide to Personal Finance - Tim Maurer (2016)

Part II. PLANNING FOR TODAY

The most important elements of personal finance are, thankfully, the simplest—but they’re not easy.

Chapter 6. PERSPECTIVE: Where Do You Stand?

WHY do I need to read this chapter?

It’s impossible to know how to get where you’re going if you don’t know where you are. You know a lot more about yourself—your motivations, values, goals, and hopefully even your calling—after engaging this book’s foundational chapters. But now it’s time to see where you stand financially, whether the situation is good, bad, or ugly.

We’ll take a snapshot of your financial landscape through the lens of the Enough Index, giving you a clear answer to an important question I know you’re asking: “So, how am I doing?”

I think you may know the answer in your gut, but the Enough Index will help explain why.

Savings Index

We will focus on four numbers to gauge your household’s financial health through a single, simple numerical score. The first number represents your financial safety margin from, well, life. It’s your money moat.

How much cash do you have on hand that is not already pledged to a creditor or near-term savings goal, like the down payment on a home or a car purchase? Often referred to as an emergency reserve, this is the buffer between you and the chief Enough buster, Revolving Unsecured Consumer (RUC) debt. More on that shortly.

Your amount of cash reserves is the best indicator of your financial stress level in the present, right this very minute. If your income this month goes to pay this month’s bills, you’re living paycheck to paycheck. I don’t have to remind you that this is stressful.

If you have a month’s worth of savings, you can breathe. But you’re not likely to outlast a major household emergency financially or survive a job loss. If you have three months’ worth of living expenses to serve as financial fortification, it’s a good sign that you live below your means. If you have six months’ worth of living expenses or more in cash, you have built yourself a nice layer of financial independence that no doubt helps you sleep better at night. Can you see how key this is in pursuit of Enough (chap. 1)?

Debt Index

The second number we’ll use to gauge your financial health is more of a red flag. It’s the amount of Revolving Unsecured Consumer (RUC) debt you owe that won’t be paid off at the end of the month. And yes, I made up this acronym.

✵ It’s revolving debt as opposed to installment debt. Installment debt has a set number of payments after which the debt will be repaid in full. Most home mortgages are installment debt, as are most auto loans and student loans. Conversely, most credit cards are lines of credit that, like flesh-eating zombies, limp into perpetuity until you annihilate them. You’ll have a minimum payment that adjusts according to the amount of outstanding debt and is primarily designed to keep you in debt.

✵ It’s unsecured debt as opposed to secured debt. A mortgage is, by definition, a secured loan. It’s secured by the home on which the bank can foreclose if you don’t meet your end of the bargain—to make regular mortgage payments. An auto loan is also by definition secured, whereas a credit card and most consumer loans are not.

✵ It’s consumer debt as opposed to commercial debt. Commercial debt is for businesses. Consumer debt is for individuals and households. A commercial loan can certainly have a meaningful impact on your business, but it does not directly threaten your personal assets. Retail credit cards are a great example of RUC debt.

In most cases, your RUC debt number is simply how much you have in credit card debt, and it tells the story of your financial past. It represents either bad luck or bad decisions (or both).

There are understandable reasons for having RUC debt. For example, a job loss, divorce, or disability. But in most cases, it’s a sign of financial instability or, at least, unpreparedness. And, even in the case of a financial surprise like those I just mentioned, a financially fortified household need not resort to RUC debt.

RUC debt is not the only variety of toxic household debt, and all forms of debt will be accounted for in the next chapter. However, RUC debt is the ultimate Enough buster for at least three important reasons: (1) It’s like the Energizer bunny—it just keeps going and going and going. And that’s quite by design. (2) It also has notoriously high interest rates, usually well into double digits and often more than 20 percent, which only strengthens its endurance. (3) But most importantly, while your mortgage may represent a housing problem, your high auto loan a vehicle problem, and your student loan an education problem, RUC debt is intensely personal and eats away at us on an individual level. It feels like a you problem, symbolizing personal financial failure.

Are you still paying for (and punishing yourself for) past financial mistakes?

Retirement Index

Once we’ve dug out of our past and raised our gaze from the present, we can consider the future. In saving for retirement, we’re really deferring a portion of our salary today to ensure that we have a sufficient income stream in the years after we stop working, whether by choice or by force.

What is your retirement readiness at this stage of the journey? Fidelity Investments pulled together some analysis1 and simplified the concept of retirement readiness by giving us benchmarks based on our age and current salary:

Fidelity Retirement Scorecard

(Source note for the above figure.2)

According to the study, you’re on track if you, for example, have half of your current salary saved for retirement at age thirty or four times your salary at age fifty. Yes, this is an oversimplification upon which we’ll expand a great deal more in chapters 11 and 12, dedicated to the topic of retirement. But for now, where do you stand based on Fidelity’s matrix?

Let’s figure out what percentage of Fidelity’s target you have reached at this point. Here’s the formula:

Mathematically, you take the multiple of the income you have saved (Your Retirement Multiple) and divide it by Fidelity’s corresponding multiple for your age. For example, if you’re forty and only have one times the amount of your salary saved when you’re supposed to have two times your income, your answer would be 0.5. Whereas, if you’re fifty-five and have seven times your current salary saved, versus the recommended five, your score would be 1.4.

How much of your future income needs have you funded?

By the way, if you’re off the Fidelity grid because you’re under the age of thirty, here’s how to compute your Retirement Index: Take the percentage of your income you’re currently saving annually into retirement accounts and multiply that number by 5.6. For example, if you’re saving 5 percent of your income (5 x 5.6) your Retirement Index is 28. If you’re saving 10 percent of your income, your Retirement Index is 56.

Giving Index

While your current level of financial health requires multiple indicators for accuracy, your overall financial satisfaction may be best gauged in a single number—the percentage of your income that you give away each year.

I must first disclaim that giving out of compulsion or guilt, in which case the personal benefits of giving are likely diminished or eliminated, may actually signify a misfiring Money Script (chap. 1) or even a financial disorder. But someone who gives healthily does so precisely because he or she has gained Enough.

Here are three reasons why giving may benefit the giver as much, or more, than the recipient:

1. Personally, you’ll feel good. Apparently we are “wired” to receive a physiological benefit from giving. It creates the same sense of satisfaction you get from a compliment from your friend or a raise from your boss. In addition to this individual sense of satisfaction, you will likely feel a greater sense of control over your own financial situation when you give to others. This positive response is especially heightened when you are able to connect yourself physically—not just fiscally—in this act of giving.

2. Practically, you’ll save money on your taxes. When you give to a qualified charitable organization, you will generally receive an income tax deduction, putting money back in your pocket for your willingness to give. Talk to your CPA to see how this will affect you personally.

3. Mysteriously, you’ll actually have more money. Once in a pattern of giving, you will likely develop a heightened sense of the needs of others and the excess in your own budget. The net effect is that you may find yourself choosing to purchase one or two fewer $5 lattes per week and staying in more often instead of going out. The result is more money in your bank account.

To what degree are you taking advantage of these benefits?

Enough Index

Okay, now let’s put all of these numbers together to arrive at your Enough Index:

Enough Index

The Enough Index is designed to yield a 100-point score if you have a “textbook” three months of living expenses saved, no RUC debt, your retirement saving is on track per Fidelity’s retirement analysis, and you’re giving away 10 percent of your income to causes outside your home. It’s not a “best-case” scenario, but it is quite stable.

To demonstrate how the weighting is handled, here’s what the “textbook” example referred to above would look like:

If you have two months of savings (2 x 8) less one month’s worth of debt (1 x 10) plus 1.3 times the Fidelity retirement scale (1.3 x 56) and you give 5 percent of your annual income to charity (5 x 2), your aggregate Enough Index score would be 88.8.

On the other hand, let’s say you have six months of expenses saved (6 x 8), no debt, you register 0.8 on the Fidelity retirement scale (0.8 x 56), and you give away 12 percent (12 x 2) of your income. In this case, you’d register a 116.8. As you can see, much like the National Football League’s “passer rating,” it’s not a 100-point scale.

What about a scenario that I fear is more likely the norm? Living paycheck to paycheck earns zero points, while having three months’ worth of expenses in debt will drop you below zero to -30. Perhaps you have 50 percent of what Fidelity recommends—a retirement score of 0.5, worth 28 Enough points—and heck no, you can’t give anything. You feel like a charity case yourself! And that’s exactly what your -2 Enough Index score is designed to reflect—how content you feel.

You’ll note that each feature is not equally weighted. RUC debt hurts more than cash savings help, and quite purposefully. The emotional damage RUC debt imposes can weigh heavily on us. This is why I would recommend in most cases that surplus emergency savings be used to pay off RUC debt. Indeed, paying an exorbitant interest rate is a financial emergency.

Some will certainly argue that not considering excessive mortgage, automobile, and student loan debt is shortsighted, and I’m sure there are a number of exceptions for which this is true. However, because these loans are installment debt and two are secured, they would not have the damaging financial or emotional characteristics of RUC debt. And, if the payments are unduly burdensome in those cases, it’s likely to be reflected in their inability to maintain cash reserves and adequately save for retirement.

Being on track for retirement, meanwhile, is weighted very heavily. This is because problems like cash deficiencies, burdensome debt, and lackluster giving, while painful, can be remedied in the relative short term. Or, at least, shorter term. And precisely because long-term investing offers us the benefit of compounded growth, this means too little retirement savings is a compounding dilemma. It’s much harder to catch up, especially as we age.

It is vitally important to understand this is not a measurement of personal worth or value, and it’s not a competition. Your score is simply designed to reflect how it feels to be you, financially speaking. And only financially speaking.

It measures the degree to which money is serving you, versus you serving it.

Selfish Generosity

Some may criticize me for weighting charitable giving so heavily, or even at all, as a measurement of financial stability. Please don’t consider my plea for generosity as sermonizing or judgmental. Yes, I do believe that there is an element of duty here, and that those who have more are called to give to those less fortunate, but my primary message regarding giving is that it will benefit you, personally, on your path to Enough.

And I don’t speak as someone who has always given generously or never suffered financially.

From the moment my wife and I were married, we committed to giving roughly 10 percent of our income to charity. We simply made the decision to live off of 90 percent of our income and we never really questioned it. Until.

When I established myself as a self-employed financial advisor, my wife became the primary breadwinner. My income ranged from zero to not much—every month—for close to two years. In the middle of that stretch, we were blessed with the birth of our first son.

Since before we were married, my wife’s plan was to sacrifice her promising career to be a stay-at-home mom, and I fully supported her in this endeavor. The only problem was that now we had numerous financial commitments—foremost among them, a mortgage—and far less of an ability to satisfy them without my wife’s income.

Incidentally, as a guy with the “My primary role is to provide and protect” Money Script (chap. 1), you can imagine how demoralizing—I mean, educational—this period of time was for me.

Have no doubt. We seriously considered the good sense behind maintaining our pledge to give away the first 10 percent of our income when our reserves dipped into the single digits and we didn’t know when the next cash infusion would come. But we pulled through.

I’m not ready to suggest that we pulled through because we continued to give. That’s a topic for another chapter in another book. But there is no question that we were buoyed personally by maintaining our giving through a trying financial drought.

Yet, somehow, we forgot that valuable life lesson.

Years later, even in the midst of our most profitable year to date as a family, we made a decision to reach financially for a new house. You know, the one with the acre of yard nestling the idyllic center-hall Colonial with room to frolic for both our two boys and soon-to-be-purchased family dog?

The only problem was that the house was a bit of a fixer-upper, and required a significant amount of work (read: money) to even come close to the ideal. To pull it off, we’d need to substantially reduce our annual giving for six months—a year, max. A small “sacrifice,” right?

That one-year period turned into several years. They were some of our best financially, but our giving (and our saving, for that matter) were down.

We had more income and more assets, but we didn’t feel as prosperous.

We had more, but it wasn’t Enough.

The Enough Index isn’t close to perfect, and it’s not designed to be. It’s designed to measure the elements of our financial lives that tend to give, and strip, us of contentment.

I invite you, if you haven’t already, to put it to the test. Reflect on your own financial situation. When you have, it’s time to move on to a more practical discussion about managing the two most essential elements of every financial plan—savings and debt. We’ll do so in our next chapter by examining exactly how much you need in savings and how to manage debt.

1. In order to gauge where you stand financially, we examine four numbers:

· Your Savings Index—Your emergency reserves are an indicator of the present state of your finances.

· Your Debt Index—Your amount of Revolving Unsecured Consumer (RUC) debt—typically credit card debt—is an indicator of your past financial decisions.

· Your Retirement Index—The amount you’ve saved for retirement, relative to your current salary, demonstrates how well you’ve prepared for the future.

· Your Giving Index—The amount you freely give measures the degree to which money is serving you versus you serving it.

2. The combination of each of these indices culminates in your Enough Index score, which is both a measure of your practical financial health and the degree to which you have attained Enough.